Incentives for solar power generation systems

With a host of tax and incentive programs, there are many reasons for taxpayers to install solar power generation systems. The tax benefits can include income tax credits, breaks on local real estate taxes, and enhanced depreciation of solar assets. However, the advantages extend beyond income tax incentives, as many states, power companies, and municipalities offer additional incentives, such as partial reimbursements or purchases of excess power generation.

These benefits vary depending on whether the system is for personal use or business purposes. Adding complexity, the nature of solar power generation systems often results in blurred lines between personal and business use and sometimes raises questions involving poorly defined areas of tax law. Determining the nature of these systems is the first step in properly reporting them.

Personal-use solar power systems

At one end of the spectrum are personal-use solar power systems. These systems are usually comparatively small, owned by an individual, and have no profit potential. They’re either not connected to the power grid, or the arrangement with the power company doesn’t facilitate the sale of excess power. A lack of capacity to produce excess power has the same result. A system incapable of generating excess power is effectively no different from a situation without an agreement to purchase it. Further, there should be no external programs compensating the owner for power generation, as such programs can create income from otherwise personal property.

Personal-use solar power systems are eligible for a federal income tax credit under Sec. 25D. This credit is available only for the taxpayer’s personal residence and equals up to 30% of the costs of qualified property installed. The cost of the system, net of the credit, forms the basis in personal property. If the system is permanently affixed to real estate, it becomes part of the real estate. This can include both freestanding (ground) mounted systems and those affixed to a structure (usually a roof) if not installed in a manner to be easily removed.

To claim the Sec. 25D credit, file Form 5695, Residential Energy Credits. For more information, see Jemiolo and Farnsel, “New and Enhanced Energy Tax Credits for Individuals,” 238-5 Journal of Accountancy 34 (November 2024).

There may also be state income credits. For example, in Massachusetts there is a solar energy credit of 15% or $1,000 (whichever is less) under 830 Mass. Code Regs. §62.6.1. Likewise, there may be local programs that pay for a portion of the system cost. Local PILOT, payment in lieu of taxes, programs that reduce real estate taxes will usually fall into the category of cost reimbursements. Any of these additional incentives further reduce the basis of a solar power system.

Is it a trade or business?

If the property does generate income, the next step is determining if it constitutes a nonbusiness activity or rises to the level of a trade or business. The classification of the activity guides the tax treatment.

While the term “trade or business” is regularly used in the Internal Revenue Code and Treasury Regulations, it isn’t defined anywhere. For a definition, court cases need to be considered. In Groetzinger, 480 U.S. 23 (1987), the Supreme Court stated that, to be a trade or business, the activity must have a profit motive and be regularly engaged in. While both factors are matters of fact and circumstance, a profit motive should be the easier one to identify for a solar power generation system.

Read the full article published by The Tax Adviser.